The disaster is the result of a combination of factors, including a slowing Chinese economy, falling commodity prices, and an industry loaded with debt.

Earlier this month, state-owned enterprise (SOE) Sinosteel defaulted on a debt-interest payment of $315 million on bond notes maturing in 2017.

It’s a sign that, despite China’s best efforts at fiscal-policy easing and pledges to reform “zombie” SOEs, the worst may be coming faster than policymakers expected.

The pride of old China

China’s economy is trying to make the difficult transition from one based on investment to one based on domestic consumption, so it’s useful to think of its economy in two parts: new China and old China.

New China includes businesses in the services sector, like technology, retail, and banking.

Old China includes the country’s once booming property and construction sectors, manufacturing, and Chinese exports.

It’s important to note that old China — which includes a bunch of SOEs — is carrying a ton of debt. This has made companies less profitable as they spend significant sums of money making payments on that debt.

As new China rises, old China is fading. But the rising is happening slowly, and the fading is happening faster than anyone thought. The Chinese government faces the colossal challenge of managing this transition without a string of credit events crippling the economy.

That’s where the danger in China’s steel industry comes in.

Asking for help

As Bloomberg reports, Zhu Jimin, the deputy head of the China Iron & Steel Association (CISA), said on Wednesday that collapsing demand is putting the entire industry at risk.

“Production cuts are slower than the contraction in demand, therefore oversupply is worsening,” said Zhu at a quarterly briefing in Beijing by the main producers’ group. “Although China has cut interest rates many times recently, steel mills said their funding costs have actually gone up.”

Average steel prices hit an all-time low on July 9. CISA notes that in September, steel demand contracted 8.9% from the same time a year before, and medium and large steel mills have lost $4.4 billion in the first nine months of 2015.

The restructure

That means China may need to both clarify and speed up its five-year plan to reform state-owned organizations. Sinosteel’s default indicates that it, and other SOEs carrying a ton of debt, may not be able to wait years for debt restructuring.

“I don’t know how the government can push ahead with the SOE reform, it will be extremely difficult,” one senior executive with China’s top aluminum producer, Chinalco, told Reuters.

Winter is coming. That means construction will slow and demand for steel will weaken more.

And when that happens, China will have to make a choice. Prop up its steel industry or make the rare decision to let companies collapse under the weight of their debt.

Discussion

2 thoughts on “A massive Chinese industry is flashing warning signs that the world cannot ignore”

I take a strong exception with the biased views highlighted in this article.

This article is typical of the China articles written for an American audience – to make them feel that perhaps Obama has not been such a disaster – and that China will not eclipse America after all.

Firstly, the risks in China’s steel and traditional industries are real. BUT the risks can be mitigated. Look how robustly China responded after the 2008 financial crisis which started in the US – China weathered the storm with a massive Keynesian investment splurge – admittedly it caused subsequent problems but it was robust decision-making.

The article does not compare to the US government bailing out the US motor industry after the 2008 financial crash.

Yes, the state corporations in China need urgent reform but so does the bloated public sector in the US, the UK, France and Japan – and, of course, the EU bureaucracy is probably the world’s most inefficient bureaucracy.

Similarly, the ‘old’ and ‘new’ could be applied to Britain’s collapsing public health service, the NHS. In this blog, John Gelmini and I have repeatedly argued in favor of scrapping the NHS and replacing it with a new best-of-breed public health service, leveraging best practice, in countries like Germany, Italy, France and Singapore. The difference between China and the UK is that the political classes in China are ready to act decisively.

It reminds me of the old saying: ‘People in glass houses shouldn’t through stones’.